As Macon Bank scurried to get in on the ground floor of the real estate heyday in the mountains, it unwittingly stumbled into a house of cards, and found itself caught up in a scheme akin to insider trading that artificially inflated high-end lot prices and duped the bank into making risky loans.

When the house collapsed, the borrowers and developer walked away largely unscathed. But Macon Bank was left with a pile of bad loans and is still reeling from the losses four years later.

The scheme started with the developer of an 800-acre mountainside called Wildflower, who lured buyers to sign on the dotted line in exchange for cash back incentives. The developer also funneled money into an escrow account to help the buyers make their mortgage payments.

On paper, it looked like buyers were lining up for the chance to pay $200,000 for lots in Wildflower. In reality, the buyers were puppets of the developer himself, a mirage intended to trick the marketplace into thinking Wildflower lots were in high demand, according to a civil suit filed by Macon Bank against a slew of players involved in the transactions.

When the real estate bust came, the developer stopped funneling money to the buyers for their mortgage payments, and the buyers walked away from their loans in droves.

Macon Bank claims the appraiser was duplicitous in the scheme, assigning the lots artificially high values so the buyers could land inflated loans with Macon Bank. Macon Bank also sued the loan officer for the deals, claiming she purposely concealed the off-the-books arrangement between the developer and lot buyers. And it sued the real estate attorney who did the closings.

The case was ultimately settled out of court.

While Macon Bank was clearly a victim, it also failed to put proper oversight in place to guard against risky loans. Rather than using an in-house loan officer, it contracted with an outside Realtor to serve as the loan officer on the Wildflower lots, turning over the reins of the all-important job of assessing a borrower’s risk to an outside player working on commission.

There’s no empirical evidence to say whether Macon Bank — or any local bank — was too aggressive with its lending practices during the real estate heyday.

“If you want to Monday morning quarterback, I think we wouldn’t do those things again,” said Roger Plemens, president of Macon Bank.

In hindsight, no bank would. But at the time, real estate was selling hand over fist, and property values were increasing faster than anyone could remember.

“The market was really hot,” said Tommy Jenkins, director of the Macon County Economic Development Commission. “I knew it would cool off. But people did not expect it to cool off to that extent. The crisis was a lot deeper than people thought.”

Experts in real estate and finance agree. The enormity of the decline was simply unprecedented, said Ken Flynt, a finance professor at Western Carolina University and long-time banking executive.

“It is important to understand over the past 70 years, really since the Great Depression, real estate has been the ultimate in collateral,” Flynt said. “It is by far the most comfortable and reliable in terms of holding value and most cases escalating value.”

Banks were victims but perhaps blindsided more than they should have been. In some ways, it should have been obvious that an enormous downturn was just around the bend. Values had increased so precipitously the other shoe was bound to drop, pointed out Steve Philo, an attorney in Franklin who specializes in real estate. If you look at a graph of real estate values since the 1950s, they show constant, steady growth until the mid-2000s.

“Then you see this marked increase all of a sudden that doesn’t fit,” Philo said. Real estate inflated so rapidly, Philo questions why government regulators weren’t jumping up and down with warnings.

“I don’t know what you do when you realize something is out of kilter, but I think they would have known it was out of kilter. The policymakers let it sail along,” Philo said.

Flynt agrees the soaring values reached unrealistic highs.

“We had a tremendous amount of fervor about living in the mountains,” Flynt said. “But, you also had the knowledge that there is still lots of dirt out there on the mountains and plenty of it. I don’t care how fast we grew, there was going to be plenty of it for a very long time.”

On the back of the banks

Banks certainly aren’t the only ones reeling these days.

“The economy as a whole, no matter if you were driving nails or making loans or selling shoes, has taken a lick,” Jenkins said.

During the height of the real estate boom, Philo had eight employees in his solo legal practice to help him handle the real estate closings he had. Now he has three.

Macon Bank had 197 employees. Now, it has 163.

The speculative building boom during the early- and mid-2000s created a ripple of wealth through virtually every segment of the economy. The spigot was flowing — thanks in large part to the banks. Local banks loaned untold millions to developers, second-home buyers and speculative land investors.

“Most of those dollars disappeared throughout the economy,” Flynt said.

The developers and builders planned on selling all those lots and homes to pay back what they’d borrowed. Instead, while everyone else got their payday, banks were left holding the bag on bad loans.

“A lot of developers, whether they were experienced or new, had a lot of capital. The problem, is they also had a lot of real estate,” said Tim Hubbs, president of Nantahala Bank in Franklin. “They were counting on some sales of that real estate to help them pay the debt. All of a sudden, it was not selling. It wasn’t just that the prices were going down; they couldn’t sell anything.”

The sale of lots essentially dried up. Developments like Wildflower, Legasus, Balsam Mountain Preserve and Simms Valley went months without selling a single lot. With no income coming in, the developers couldn’t pay their bank loans.

Hundreds of properties landed in foreclosure on the courthouse steps, where they would ultimately fetch pennies on the dollar compared to what the bank had originally loaned out.

Commerce in Western North Carolina had a field day on the backs of local banks. By the same token, had banks put their foot down and not made loans that in retrospect proved overly risky, the field day may never have taken flight like it did.

But banks let their guard down in the real estate frenzy, making riskier loans and requiring smaller down payments than they once did. At times, Macon Bank required only 10 percent for a down payment on lots — far less than the industry standard.

If lots appraised at $200,000 a pop, and indeed were selling for $200,000 a pop, why not make the loan?

Typically, lots and land are considered more risky than a house — more prone to fluctuation and less likely to fetch a steady appreciation in value. As a result, land and lots require a bigger down payment — usually in the 25 percent range. The down payment ensures the buyer has some of their own skin on the line and is less apt to default or walk away.

The down payment also serves as a cushion if the bank has to foreclose. That cushion has normally been enough to pad banks from a loss. But then again, losses had never been this steep before.

“Who would have thought that it wasn’t enough?” Plemens said. “I think everyone thought there would be a decline in value, but I don’t think anybody thought it was going to decline as much as it did.”

Lots and land have seen a 50 percent decline on average, and an 80 to 90 percent decline in some instances.

The more generous loans weren’t intended for speculative buyers or investors, but for people genuinely planning to build on the lot within a couple of years.

“Hopefully you get the lot loan and then end up with a construction loan,” Plemens said.

But when the economy tanked, even those with the best intentions of building a house on their lot sidelined those plans. In other instances, the bank was flat-out misled by borrowers who claimed they planned on retiring here or building a second home — but in fact were merely speculators intending to flip the property for a swift return.

Regardless, the smaller down payment banks were offering on lots during the height of the boom came back to bite them. Now, the bank was holding loans on property with only a small down payment cushion — making the losses sting that much more.

New day in lending

Banks nationally have retrenched on their lending practices, cinching up the purse strings on loans they once would have jumped at. The same is true locally.

Some banks, like Macon Bank and Nantahala Bank, are being monitored by the Federal Depositor Insurance Commission and are under a mandate to be more conservative in lending. Macon Bank isn’t making any loans on lots or land, for example. Philo said anyone he’s seen buy land or a lot in the past couple years has had to do it with cash.

Banks are also rarely lending money to builders for speculative homes anymore either. A few years ago, builders were entering the spec home marketplace in droves. It seemed anyone who could swing a hammer and amass enough cash for a down payment could land a loan to build a house. They’d sell the house then pay back the loan, making a tidy profit for themselves.

When the market dried up and they couldn’t sell the spec house they’d built, they couldn’t make the loan payments and fell into foreclosure.

“They don’t call them ‘sure-thing’ homes. They call them spec homes for a reason,” said John Tench, a vice president with HomeTrust Bank in Waynesville.

Banks haven’t taken everything off the table, however. They are still making loans.

“Our risk appetite has changed, but it is still there to make loans to businesses and individuals,” Tench said. “As far as being a risk-taking business, that’s what we do. We analyze risk.”

While some banks have pulled the plug entirely on construction loans, Old Town Bank says people borrowing to build their own home don’t carry the same risk as contractors trying to build and flip houses.

“There is a difference when you lend like that than if you are lending spec,” said Charles Umberger, president of Old Town Bank.

Bust on the horizon

When the rest of the nation began bracing for a real estate crash, WNC proudly declared itself immune, at least immune from the brunt of it. Our quality of life is great, views are gorgeous, climate is ideal — people would never stop wanting to move here.

For a while, it seemed the mountains would be spared. But only for a while.

“We caught up with the rest of the nation,” Tench said. “It was slow to start. We didn’t get hit as quickly, but we caught up to them.”

For Nantahala Bank, signs of choppy waters ahead became apparent by 2008.

“You definitely knew something was going down. Everybody was hoping it would be something that would last six months to a year,” Hubbs said.

Banks, of course, weren’t the only ones to suffer.

“There is no doubt the construction and real estate market, new home construction and real estate sales were the main economic driver for Macon County and all of Western North Carolina,” said Jenkins, director of the Macon County Economic Development Commission. “When that bubble burst in 2008, it had a devastating effect. It affected employment, it effected the wealth in your community and quite frankly made it hard on all businesses in all sectors.”

It did serve as a wake-up call, however.

“We can’t put all our eggs in one basket,” Jenkins said.

When HomeTrust Bank detected the signs of a real estate downturn on the horizon, it began shoring up its reserve ratio.

“Early on, we began preparing for the challenges our customers were facing by allocating more dollars to loan loss reserves to have the ability to manage the course with them,” Tench said.

Some banks perhaps ignored the writing on the wall, instead opting to believe their newfound fortunes were here to stay — or at least made changes too late.

One bank that was on the conservative side, Old Town Bank in Haywood County, approached lending with a bigger dose of skepticism than some. A latecomer to the real estate frenzy, Old Town Bank didn’t open its doors until 2007. That fact alone saved it from the speculative lending heyday between 2004 and 2006. But it also shied away from loans other banks might make.

“The local board and local loan committee said early on, before the crash and burn came, that things are getting a little tough. They are getting too frothy,” said Umberger. “These numbers aren’t sustainable. There is no way this can continue and continue and continue. We need to be very responsible and prudent in the way we lend, particularly on real estate.”

Old Town Bank limited the number of loans it would make in a particular subdivision, for example, to avoid being too heavily concentrated in one development should it go under.

It also tried to weed out speculative buyers who saw real estate in the mountains as a sort of stock market, and thus are riskier borrowers. They are more likely to walk away if their investment turns sour, or when the prospect of a return fades. It’s much easier to walk away from or write off a bad investment. It’s much harder to watch the bank foreclose on your lifelong dream of retiring to the mountains.

“If someone is out of state, doesn’t live here, is buying a lot with no specific plans to construct on that lot, then we are going to underwrite that loan a lot more conservatively than if someone is living here, working here,” Umberger said.

Being conservative — requiring higher down payments or turning down loans other banks were willing to make — potentially means Old Town Bank left money on the table, loans it could have profited from had it only seized the day.

“Your first role as a bank is to be there when the times get tough. I would rather be a lender that people criticize for being a little too conservative when times are good and still be there and be able to lend when times are bad,” Umberger said. “We could still lend after other people had to stop lending.”

Walking away

Banks faced another wildcard in the real estate meltdown. Historically, foreclosures were a last resort for families who fell on hard times. Banks can usually work with those borrowers, such as refinancing the loans with smaller interest-only payments or offering some breathing room until they get caught up.

But when real estate prices crashed, that dynamic changed.

“The ones that are a problem are the ones that had the ability to pay but said, ‘I don’t want to’ and they walk away,” Hubbs said. “If they say ‘I don’t want to pay anymore,’ and everyone is telling them just walk away, including the national media, guess who gets left holding the bag? It is Nantahala Bank and Macon Bank, which are owned by the people in our communities.”

Hubbs said it isn’t ethical to walk away from a bad investment and stick the banks with your losses.

“If you have something you are upside down on, I didn’t make the investment, you made the investment, and then to say ‘I’m not going to pay,’” Hubbs said.

Those who walk away would justify it in their own head as a “business decision,” Flynt said. Why keep making payments on a $200,000 loan if the lot is now only worth $30,000.

“They have the realization or anticipation that in my lifetime I will never see this thing appreciate back to what I bought it for,” Flynt said.

When to pull the plug

Foreclosure is a last resort for banks, especially when the real estate market is floundering.

“There is no formula that tells you at this point to do this or do that. We look at each case on its own merits to see if there is anyway to support these families and businesses and see if we can come out on the end together,” Tench said.

A borrower who isn’t making payments, but who hopefully, maybe, possibly, could start making payments again in the future is often viewed as a bird in the hand.

Once a bank forecloses, the bank takes a hit to its balance sheet if it can’t sell the property for what it had loaned. As long as the loan stays active, however, it isn’t posted as a loss. The property stays listed on the bank’s books at whatever value it sold for at the time the loan was made.

Once the bank forecloses, it has to adjust its books with property’s actual value — based on a new, up-to-date appraisal.

The downward adjustment of property values during the foreclosure process has been the crux of the problem for many banks.

To make matters worse, every year, any foreclosed properties that are still sitting on the bank’s books have to get appraised again. If values have fallen even further in the intervening year, the bank takes another hit to its balance sheet.

Most banks prefer to sell off any foreclosed properties as quickly as possible since they’ve already posted the loss on their books. Wheeling and dealing foreclosed properties has become a cottage industry nationwide. HomeTrust Bank created a web page specifically dedicated to its foreclosed properties up for sale.

Nantahala Bank is taking a different approach, however. The bank isn’t eager to unload homes at rock bottom in a depressed market.

“I don’t want my shareholders to have to bear additional losses, especially if I believe the value is improper,” Hubbs said. “Instead of selling them, we are just renting them.”

Nantahala Bank is making about $120,000 a year renting foreclosed houses. It’s not a lot, but it’s not bad either.

“I am not having to pay the upkeep — the power bill, mowing the lawn — so my cost of carrying that real estate goes way down,” Hubbs said.

Dumping foreclosed properties into the real estate marketplace can be counterproductive for banks. They want to fetch the highest price possible, but with so many homes and lots up for sale and few buyers, prices become even more depressed, Flynt said.

“The more you let properties go, the faster they diminish,” Flynt said, describing a spiral effect.

It’s no wonder banks will bend over backwards to help a borrower along and keep from foreclosing. Banks can even be tempted to loan more money to a borrower who’s in default to help them make their mortgage payments and appear to be current.

Typically, the FDIC frowns on banks loaning a borrower more money simply to make their own mortgage payment, especially if the bank deep down knows it’s only staving off the inevitable.

“All you are doing is lying to yourself about the losses you should take,” Hubbs added.

But it can be kosher. For example, the borrower would be in the process of selling their house, at which point they’ll pay off what they owe.

“Does it make sense for the bank? Can you rehabilitate that borrower to get them to the point they can pay?” Plemens asked.

“We’ve had a dozen of those in the past year where it makes sense,” Hubbs added.

It’s the same quandary a bank faces anytime it’s weighing whether to pull the trigger and foreclose or let a borrower do a workout.

“A lot of it is ‘Are they being realistic? Can they make their payments? Do they have it on the market at a price it is going to sell?’” Plemens asked.

What’s your outlook?

Bankers and Realtors who are eager to see real estate values rebound are more apt to predict that a turnaround is just around the corner.

“If everybody sees the bottom they will say, ‘Hey I got to buy now because they say it is never going to be this good a price again,’” Hubbs said.

It could be wishful thinking.

But one of these days, probably soon and perhaps even right now, the market really will be at the bottom.

“Someday, some year in the future, we will all look back at charts tracking 10-year trends and somewhere around here — whether it is 2011 or 2012 or even 2013 — we’ll look back and say, ‘Ah, there was the turn. How come you didn’t know it back then?’” Umberger said. “But when you are living month to month, it is real difficult to call a turn.”

The bottom of the trough can be tricky to detect until it is clearly behind you.

“I thought we were in the formation of a bottom a year ago, but when you are forming a bottom it looks an awful lot like a saw tooth, not the nice neat kind but a logging saw with teeth that are irregular,” Umberger said.

Conventional wisdom holds that construction and development won’t resume until the inventory of homes already on the market is cleared out. And there are houses that have languished on the market for years without a taker. But that alone doesn’t mean the market is sluggish.

“People just don’t want those houses,” said Hubbs, who sees signs of buying and new building on the horizon.

Steve Philo, the real estate attorney in Franklin, also says activity has picked up this year.

“Do I think it has bottomed? Yes, I think the indications are that it has,” Philo said. “We are seeing a more steady flow of closings.”

For a while, the only people buying homes were locals who actually needed a house. Now, the retirees and second-home owners are creeping back into the market.

The sting of the real estate crash should resonate for years if not decades, however. Land in Western North Carolina has lost its status as a risk-free investment, a safe harbor for investors with extra cash hoping to out-perform the stock market.

“I think the basic is if you can’t afford to lose the money then don’t gamble with it. And if you don’t know what you are doing then stay out of it,” Philo said. “To me that is the lesson for the consumer.”

For the banks, there’s no turning back. It’s a storm that must be ridden out.

“What you want is the management and vision and sufficient capital to survive it,” Tench said.